The European Central Bank has warned Europe’s lenders will face regulatory action unless they urgently address “material deficiencies” in the risk management of trading counterparties such as hedge funds, family firms and commodities traders.
ECB supervisor Andrea Enria issued the warning in one go blog entry Outline counterparty credit risks and ask them to make a number of improvements, such as:
The ECB’s call reflects growing regulatory unease about the potential for contagion after the implosion of family office Archegos in late 2021 exposed gaping weaknesses in the counterparty risk management of banks’ capital markets operations. The Bank of England wrote to its top lenders on Tuesday, criticizing them for not doing enough to de-risk their dealings with non-bank financial institutions.
Despite releasing guidance on better practices in August, Enria said there were still “significant deficiencies” in the operations of the 23 euro-zone banks that the ECB has focused on because they are most active in derivatives and securities financing markets with non-banks -Financial institutions are.
“Institutions need to go beyond mere compliance with regulatory requirements when designing their approaches, which should be appropriate to the scale and complexity of the business, the products offered and the nature of the counterparties,” Enria wrote in the post published on Friday, adding the institute also need systems that “can keep up with the increasingly fast-moving and complex market situation”.
The ECB has issued a series of recommendations on how banks can better manage risk with their trading partners, which banks use to increase their bets on stocks, bonds, commodities and derivatives.
The ECB wants banks to improve their due diligence and see a customer’s failure to disclose information as a red flag that would lead to a more “conservative” approach to the customer’s creditworthiness “or even to customer rejection or spin-off”.
Enria also wants banks that have large exposures to trading counterparties to be more explicit about their approach to each relationship by clearly stating this in a risk appetite statement. There should be bank-wide processes for dealing with counterparties in difficulty, rather than ad hoc measures that have at times resulted in regulations being “relaxed under commercial pressure,” he added.
The supervisor also called for better stress testing and oversight of trading counterparty risk, particularly in relation to non-bank financial institutions such as family offices, hedge funds, insurers and private equity firms.
Enria said his superiors would visit some banks’ offices this year to ensure they are meeting ECB expectations and “use the full range of supervisory tools to ensure supervised banks promptly address weaknesses in their risk management framework.” “.
Global regulators are also stepping up efforts to directly regulate non-bank financial institutions, which had looser oversight than banks and are now accountable almost half of global financial assets, according to a December 2022 report by the Financial Stability Board.
https://www.ft.com/content/6000e74a-5d2f-4393-b48b-6c5567e60995 The ECB is asking lenders to address risks in hedge fund and family business trading